MEMBER NEWS Non-Qualifed Deferrred Compensation In A Nutshell A NQDC in Action Here is an example of how an arrangement would nonqualified deferred compensation (NQDC) arrangement is simply a means of supplementing a key employee’s retirement income and providing survivor benefits. It is a contractual fringe benefit arrangement under which an employer promises to pay specified benefits to a key employee in the event of disability, retirement or other future separation from service. In other words, NQDC is an arrangement where an employer promises to pay an employee in the future for services rendered currently. Should the key employee die prior to retirement, specified amounts would be paid to the key employee’s beneficiaries. Employers use the selective fringe benefit as a part of an overall compensation package to attract, motivate and retain key employees. Since an NQDC arrangement is simply a “substitute” for, or supplement to, current compensation, it is possible to obtain a better balance between present earnings and future retirement income. The deferred benefits, instead of being paid and taxed now, are received after retirement. This maximizes the value of the key employee’s chief asset, his or her earning power, and lessens the need to personally accumulate retirement funds. Once an NQDC arrangement is adopted for one or more selected key employees and implemented by a written agreement, the employer incurs a future liability to make specified payments. It is a sound business practice to hedge this liability by establishing some type of reserve fund from which the payments can be made. Although they must be “unfunded” and employees receive only an unsecured promise from the employer, the benefit obligation may be “financed” through a planned investment strategy. Life insurance is ideally suited for this purpose and is recognized as one of the most practical and economical methods of ensuring the funds for such arrangements. Further since they provide pre-retirement salarycontinuation death benefits to the key employee’s family, life insurance can fully and instantly create the funds necessary to complete the arrangement. The income tax-free death proceeds received by the corporation will offset its after-tax cost of providing these benefits. (In some cases, the alternative minimum tax may apply.) 24 | HBRA of Fairfield County | MARCH 2017 work: Wishing to retain the services of one or more valued key employees, ABC corporation establishes an NQDC arrangement under which it agrees to pay $50,000 per year for 10 years beginning at age 65, provided the key employee remains with the corporation until retirement. If death occurs before retirement, $50,000 will be paid each year for 10 years to the key employee’s family, and in the event of death during the retirement pay-out period, any remaining payments will continue to the family or estate. To help meet its obligation, ABC purchases a life insurance policy on the key employee’s life. ABC will be the owner and beneficiary of the policy. While ABC cannot deduct the premiums it pays, the income benefits eventually paid to the key employee or his or her family can be tax deductible as payment of reasonable compensation. Benefits received by the key employee or family are taxable as ordinary income. Meanwhile, the key employee can feel secure knowing that ABC corporation has a means to help pay for future benefit payments. Advantages to the Employer For an employer, a NQDC arrangement: • Attracts talented people – High-caliber employees are always in demand. To compete successfully for new employees, employers must offer attractive compensation packages; • Retains key employees – The payment of NQDC benefits is usually contingent upon performance. For example, the employee will receive the promised retirement and death benefits only if actively employed at the time payments commence; • Is a selective fringe benefit – The employer is not required to include all employees in this program. The key employees know they are among the “chosen few” selected to participate in the program; • Is a flexible fringe benefit - An NQDC arrangement can be individually tailored to complement other salary and benefit programs. Special consideration may be given to the employee’s objectives when designing an arrangement; • Has a cost that may be predictable; and
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